Monday, December 9, 2013

The work required to have an opinion

The stock market is a very interesting place, because for every transaction you have a buyer and a seller who both think are smarter than the other person. Unfortunately, only one of them ends up making money. As a dividend investor, I am exposed to opinions all the time.

I usually choose to ignore other’s opinions. I suggest you also implement a filter on who to listen to. I will explain why in this article.

My strategy is based on purchasing shares in undervalued dividend stocks, that have a history of growing distributions. I make these purchases after analyzing these companies one at a time, and find a catalyst that would help each company to potentially earn more in the future. This could include the ability to increase prices ahead of costs, cut costs through increasing efficiencies, expand in new markets etc. The rising profits at the company level could then fuel future dividend growth. I spend my free time reading about companies I own, and reading about companies I want to own, while waiting for prices to get down to a reasonable level before I invest. I also spend time thinking about my investments, monitoring them, and asking myself if the companies will still be relevant 20 years from now.

My financial well-being in retirement is based on my own efforts to do the work and choose stocks wisely. This is why I am more prone to be overly conservative, because I would rather be safe than sorry. However, this provides me the incentive to not only avoid losing principal at all costs, but also avoid getting into dogs that use my capital but fail to shower me with a growing pile of cash every year. I have confidence in my work as a result of the process I have, following the stocks I follow and monitoring my investments. I know that I won’t win every single time, and I know I would probably do many stupid things along the way. That is ok, as long as I learn from them and on the aggregate I am ahead.

I view others opinions as merely obstacles that prevent me from executing my own strategy. There are many negatives associated with taking someone’s opinions to heart:

- If you get conflicting arguments against a stock you strongly believe in, you might get hesitant and fail to pull the trigger. Any time I buy a stock there is always a reason not to buy it and someone to point that reason in my face. As an investor however, my goal is not to be right but to make money. Very often these “reasons” not to invest are merely useless pieces of random information that won’t affect the profits of the company you are investing in. For example, tobacco has been known for its harmful effects on health, yet companies like Altria (MO) have delivered some of the best returns to investors over the past 20 – 30 - 50 years. The thing that mattered is that hiking cigarette prices and cutting costs outweighed decreasing number of smokers. Actually some of the best times to buy a security is when everyone hates investing in it. Back in 2008 – 2009 everyone was expecting the world as we know it to end, and for a while it did seem that way. Yet in hindsight, this was the time to put every dollar you could get your hands on quality dividend growth stocks selling at ridiculously cheap valuations. I did buy a lot of stocks back in 2008 – 2009, but in hindsight I should have bought more.

- The person who is criticizing you might not know what they are talking about. Very frequently I get in touch with someone who is biased based on limited amount of homework they have done. Quite often, these individuals might have overheard something, and might have decided for themselves that it is the truth, and would not hesitate to present their opinion. For example, since 2009, people have been scared of hyperinflation because the Fed had pumped billions of dollars into the economy. As I had explained earlier, the government simply stepped into the economy, to substitute the private sector that was afraid to do much. Yet, a reader told me that they won’t read my site anymore, because I was wrong. I wish them well, but I can’t let what my readers might or might not think influence my investing strategy.

- The person who is giving you their opinion might be out there to sell you something. Any time I talk about dividend investing, someone always tells me that it is a bad strategy because they think so. One financial adviser routinely bashes dividend investing (link to my rebuttal), but I assume he does that because he feels threatened that self-directed investors would not need someone to hold their hands in exchange for a percentage of their assets every year.

- The person who is criticizing you might be focusing on minutiae (missing the forest for the trees). For example, I often hear things that illustrate that the person I discuss investments with is focused on recent events that they might have heard on the radio, TV, newspapers etc. These items might be great for selling newspapers, but that might not make them relevant to an investor. Back in early 2008, everyone was convinced that Oil was going to $200/barrel, that the US dollar was toast and therefore companies should have international exposure. After Lehman failed, the rest of the world was not doing well relative to the US dollar, and therefore international exposure was bad. For any serious long-term investor, currency fluctuations in the global operations of multinationals like Phillip Morris International (PM) are mostly a wash. Do not let them influence your decision to buy or sell a stock. In addition, companies that fail to meet or exceed Wall Street estimates by a penny and sell-off, provide another example of minutiae or irrelevant facts that you should mostly ignore in your decision making. If you hold Coca-Cola (KO) for the next 20 years, would it matter if it had one bad quarter in 2014 where it missed Wall Street consensus by 1 penny?

- There are always two sides to an argument – For example, some investors want to concentrate their portfolios in less than 10 stocks, others want to hold as many stocks as possible, while a third group might fall somewhere in the middle. For example, I fall closer to the group that espouses owning as many companies that are of good quality, if they are purchased at fair prices and offer the possibility for long term dividend wealth creation. I am totally fine with the fact that investors would disagree with me on holding positions in 50 – 60 securities. This is because what I do is meant to accomplish my goals, and not what Joe thinks of my strategy. As an investor, you should do what you are comfortable with, as long as you have a good reason and have done the homework on the topic. If you built your portfolio of 40 stocks over the past decade, but none of them are buys today, it might make perfect sense to purchase 10 - 20 additional quality companies that are available at reasonable prices. Otherwise, you might find yourself with too much cash on hand, which could cause pressure that you are missing out, especially if prices start rising.

- The persons you are talking with, might not understand your strategy or have a different strategy. For example, when I purchased shares of IBM after it fell in October, a reader posted an analysis of the company from another source. The other source mentioned that the stock should not be acquired. I replied to the reader that I do not care about this other analysis, because I was following my strategy. One should not never others opinions influence their decisions, particularly if they have done the work needed to have their initial conviction in the first place.

If you have done the work, someone who doesn't agree with you should not have an impact on your decision. In fact, some of my best bets have been at a time when the majority of investors disagreed with me. Actually, since 2009, it seemed that almost everyone disagreed with me on buying stocks.

However, if I found out new and material information about my investment, I should evaluate whether it impacts my analysis or not. But if you let random people's opinions influence your decisions, then you are doing yourself a disservice.

- They might be bad investors. The thing is that I do not take others opinions into consideration, because I never know if the person has done their homework, what their level of experience is, and whether they are using facts, or whether they are simply biased against something for whatever reason. However, I do review these opinions especially if they come from someone who I regard as knowledgeable. Those are not only the Warren Buffett, Charlie Munger, and Peter Lynch of the world however. It could be an ordinary investor, who can also provide some you with a nice dose of common sense when you most need it. These investors are rare, but once you find them, hold on to them for their opinion. If I learn a fact that I have not come across during my analysis of a stock, I would seriously consider it, and determine how it impacts the probabilistic outcome of my investment, if it came from a reputable source. I do not subscribe to conspiracy theories on investment matters however. For anyone else who is untested, you would do well for yourself if you ignore them, after applying your BS filter.

The truth however is that sometimes, investors make mistakes. I make my fair share of mistakes on a monthly basis. Input from other smart investors can catch any blind spots in my research. However, if I had done a good job in analyzing securities, any “opinions” I receive should not bring anything new to the table. If they do bring something new and material, then I should definitely evaluate them. For example, when I was first starting out as a dividend investor in 2007-2008, I analyzed Realty Income (O) and determined that it was a terrible investment. This was because I was doing the mistake of looking at earnings per share, and hadn't even heard about Funds From Operations (FFO). After I learned about my mistake, I did some work researching this new theory on valuing REITs and determining for myself whether it made sense. I realized I was wrong, and in a subsequent analysis decided it was an attractive investment. As you gain experience in investing, you would notice certain recurring opinion themes you need to ignore at all times, such as conspiracy theories or constant doom and gloom. However, you should also be able to distinguish opinion that are well grounded in facts, which require further investigation on your part.

Another example includes my attitude towards taxation and investing. For as long as possible, my attitude has been that my goal is to earn money first, and only then worry about taxes. However, after reviewing my tax situation for several years I realized I was wrong to ignore taxation issues. If I have to sell a stock, I sell it regardless if it would produce long or short-term gain, since I don't want to turn gains into losses. However, I am trying to max out 401 (k) and IRA accounts today, in order to gain the most in tax benefits. My goal is to then convert those amounts slowly into a Roth IRA after I retire. I was inspired by blogger J Money on gaining the most in tax deductions today. However, I think I came up with the idea to perform a Roth IRA rollover and pay low taxes on it myself. I think.

Another example includes my recent monitoring of Procter & Gamble (PG). I have been accumulating the stock of this dividend king for several years. However, while it has been able to increase dividends every year for over 5 decades, it has been unable to increase earnings per share since earning $4.26/share in 2009. This means that dividend growth has been running on fumes over the past four years, while I have been patiently hoping for earnings growth to materialize. This means that I should not be buying more shares in this company for the time being. I would still be holding on to my shares, as the risk of dividend cut looks remote. At this point it looks as if future dividend growth would likely exceed inflation only slightly. As a long-term investor, you sometimes have to be able to change your mind, when presented with facts that might run contrary to your opinions too. I think that Procter & Gamble is a core holding for any dividend investor, but if the company cannot grow earnings per share over the next decade, I would not add any money there and would use the dividend checks elsewhere. If they cut the dividend, I would close my position one minute after the announcement.

This is why investing is more of an art than science – you can probably ignore the opinions of the people that haven’t done any homework, but you should be aware of differing opinions that bring a material fact you haven’t previously considered. By practicing the art of stock picking for a long time, you would likely be able to distinguish which one deserves your attention, and which group doesn't.

Full Disclosure: Long PG, O, IBM

Relevant Articles:

Check the Complete Article Archive
Dividend Investing is not a black or white process
Dividend Investing – Science versus Intuition
Dividend Investing Goals for 2013
My Dividend Retirement Plan

6 comments:

  1. DGI,

    Thanks for the article. I've read it and learn a lot from it. Everyone is entitled to an opinion and many may believe that they have a better solution than what is relevant to you and that you have already experienced and fits your requirements.

    I honestly believe that the benefit when communicating with other investor should be about how you do and not what you do. After all picking a Stock is also an Art and a personal choice.

    You are very clear in your objectives and it helps a lot to understand your process.

    One thing that you stated and I need to improve in my process is about reading more about the companies and their reports. Meaning being less technical (Charts) and more 'fundamental' (Business, sector, etc).

    I am sure that reading your Blog will help me with it.

    Like you I try to avoid people trying to sell me solutions or services. I truly believe that there is value in learning and doing ourselves, patiently but steady.

    Thanks,
    DT.

    ReplyDelete
  2. Thanks for an excellent article. I agree with your viewpoints and practice them myself as a full time investor. It is important for investors to be cautious and thorough when making investments. Protecting the principal is paramount, and hence the entry price and investment thesis (why the stock will increase, in my case usually due to increased earnings and dividends) are crucial.

    ReplyDelete
  3. DGI,
    A well thought out posting today. Often I go against the grain. As far as MO, I bought it around '2000 for 20 bucks. Since then, I have bought it again many times, all on dips, most notably at $15 during the financial crisis. I still have every share, and all related spin-off shares. It is important to tune out the noise and do your own work. And, although I respect your opinion and have learned much here, if I don't agree with you I go my own way, but don't make a federal case of it with you. It's as it should be and othes should do the same. Ideas are being shared here and nothing more.

    Keep the faith, don't let the turkeys get you down, keep writing to inform, enjoy the holidays.

    Merry Christmas,
    A

    ReplyDelete
  4. DGI,

    Great post. I agree 100%

    You know what they say about opinions....

    People tend to have a herd mentality. If they go against the grain they're afraid of failing and being laughed at. Yet, if the herd is walking right off a cliff they'll follow along because if they're wrong then so is everyone else.

    I say form a reasonable strategy based on your unique goals and stick with it 100%. Ignore the noise and be persistent. That's what I've been preaching since day 1.

    Keep up the great work!

    Best wishes.

    ReplyDelete
  5. Hi Dt,

    Thanks for stopping by. You nailed it by saying that stock selection is more art than science. You need a set of criteria, but also need to know when to "break" them.

    Skip,

    Thanks for reading the site. As Buffett likes to say: " The first rule is to never lose money. The second rule is never to forget rule number 1".

    Anon #2 - A

    I appreciate your comment. I agree with you 100% - you should follow your own strategy that makes sense for you, and not blindly follow what someone else is saying. I applaud you for that, as very few investors actually can do what you do. I strongly encourage all readers to do their research before buying a stock, and not buy because I am buying.

    DMantra,

    Thanks for stopping by my friend. Going against the herd is usually a very tough thing to do, and that is a good point you are bringing. Being persistent in following your strategy is important, as there is so much noise out there, whose goal is to confuse you. This would prevent the serious investor from reaching their goals. If we abandon our strategies today for trading in TSLA, we might not be able to retire in a few years.


    ReplyDelete
  6. Really great article. I really enjoy the discussion of the social element of investing these days. I think it really hits home with newer investors who might be more inclined to question their decisions, or seek out the advice of others.

    I'm a total newcomer to this arena, but in discussions with many different people over the last year or so, I have already experienced a fair bit of what you discuss here. The "you can't possibly know more about this stuff/do better than a professional" is the first response, as many people are inclined to defend the process they are used to for fear that they might be losing out. After that is the "if dividends were so good than everyone would be doing it" which I am not even inclined to comment on, but I normally respond that more people are than you think. And lastly, "and you learned all that stuff from blogs!?"

    I guess it's a new way of learning which is foreign to many people, but if I want to learn something, I don't immediately try to find a professional...I seek out regular people who seem knowledgeable and who like to talk about the subject. Then I learn by doing.

    The advice of others is entertaining, but as you said, your decisions should be based on your strategy and your goals. No one else knows or cares more about that than you do.

    ReplyDelete

Questions or comments? You can reach out to me at my website address name at gmail dot com.

Popular Posts